A Lesson in Rebounding from Bad Investments, Illustrated by J.C. Penney

JCP  JCPenney J.C. Penney JC Penney store mall shopping exterior 2013
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If you're an investor, at some point, at least one of your investments will turn out to be a colossal failure. In fact, it's quite likely that over your lifetime, you'll invest in multiple companies that don't live up to the expectations you had at the time you bought their stock.

When an investing flop happens to you, you'll want to be in a position to simply lick your wounds and move on, with no real impact to your life. But to do that, you'll have to set up your portfolio in advance to be able to handle those failures successfully.

Can You Tell in Advance?

Take clothing retailer J.C. Penney (JCP) as an example of a company that may now be on the road to bankruptcy. Its cash flow problems and debt hangover are incredibly apparent today, but it wasn't so long ago that it looked like it had a solid future. Its shares peaked above $86 in February 2007, and its annual report published in 2007 included the chart below showing how an investment in J.C. Penney trounced the market over the prior five years:

Chart from JC Penney annual report for the year ending Feb. 3, 2007.
Chart from J.C. Penney annual report for the fiscal year ending Feb. 3, 2007.
Indeed, J.C. Penney had a lot to be proud of in its heyday. In that same annual report, it boasted of earning $4.96 a share in profits and raising its quarterly dividend to 20 cents a share. Unfortunately, as we all know, the retailer's fortunes have changed dramatically for the worse. J.C. Penney hasn't paid a dividend since 2012. In addition, the company's recent announcement that it closed the fiscal year with more than $2 billion in liquidity simply calls attention to how precarious its situation is. Its stock has tumbled to the neighborhood of $5.

While there's still a chance that J.C. Penney can turn itself around and avoid bankruptcy, at this point, it'll certainly be an uphill battle. But still, to an investor looking at the company in early 2007, J.C. Penney looked like a decent growth story, not a potential disaster.

What Can You Do About It?

Unless you've got a working crystal ball, you've got almost no chance to sell at the high-water mark of any company's stock. Instead, one of the best things you can do is diversify your investments so that the fallout from any one company's failure doesn't destroy your overall portfolio.

%VIRTUAL-article-sponsoredlinks%Until December, for instance, J.C. Penney was a member of the S&P 500 Index (^GSPC). The S&P 500 and the SPDR (SPY) ETF that tracks it had a stellar 2013, even as J.C. Penney was busy falling apart as a member of that index.

Diversification won't keep you from making investments that go bad, but what it can do is protect your overall portfolio from the implosion of any one part of it. The difference between how J.C. Penney performed and how the S&P 500 performed in 2013 is a key case in point of how diversification can protect your portfolio.

In addition to diversifying, you should regularly review each of your investments to make sure it's still worth owning and still playing an appropriate role in your portfolio. If you buy individual stocks and bonds, you need to make sure the companies behind those investments are still operating to expectations and are reasonably valued in the market. If you buy funds, you still need to rebalance to keep any fund or asset class from growing to be a disproportionately large part of your overall portfolio.

The Foundation of a Decent Plan

No matter how you invest, the one-two-three combo of diversification, review and rebalancing plays an important role in protecting your portfolio from the catastrophic failure of any one part of it. Still, there are times when the overall market will swoon and reduce the value of darn near everything you own. For those times, you need the patience to let the market do its thing and the confidence in the long-term strength of your overall strategy to see you through. With an overall plan built in a way that protects you from getting wiped out from the inevitable failure of part of your portfolio, that patience and confidence is a lot easier to achieve.

Motley Fool contributor Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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A Lesson in Rebounding from Bad Investments, Illustrated by J.C. Penney

Plenty of Americans live beyond their means but don percentt even realize it. A 2012 Country Financial survey found that more than one-half of respondents (52 percent) said their monthly spending exceeded their income at least a few months a year. Yet only 9 percent of respondents said their lifestyle was more than they could afford. Of the 52 percent who routinely overspend, 36 percent finance the shortfall by dipping into savings; 22 percent use credit cards.

Blowing your entire paycheck (and then some) each month isn percent an ingredient in the recipe for financial success. Neither is draining your savings or running up card balances. To rein in spending, start by tracking where the money goes every month. Try to zero in on nonessential areas where you can cut back. Then create a realistic budget that ensures you have enough to pay the bills as well as enough for contributions to such things as a retirement account and a rainy-day fund. Our household budget worksheet or an online budgeting site can help.

If you're like most folks, your savings habits could use some improvement. The personal savings rate in the U.S. is just 4.9 percent of disposable income, down from a high of 14.6 percent in 1975. Only about one-half of Americans (54 percent) say they have a savings plan in place to meet specific goals, according to a 2013 survey commissioned by America Saves, a group that advocates for better saving habits.

Saving needs to be a priority in order to build wealth. Begin with an emergency fund that can be tapped in the event of an illness, job loss or other unexpected calamity. A 2012 survey by the Financial Industry Regulatory Authority found that 56 percent of individuals say they have not set aside even three months' worth of income to handle financial emergencies. Once your emergency fund is well under way, you can divert small amounts toward other goals, such as buying a home or paying for college. These six strategies can help you save more, no matter your income.

Americans have $846.9 billion in credit card debt alone. That's $7,050 per household, according to NerdWallet.com, a Web site that analyzes financial products and data. If you're only making minimum monthly payments on $7,050, it'll take 28 years and cost you $10,663 in interest before you're debt-free, assuming a 15 percent interest rate. And that only holds true if you don't make any additional charges.

Some debts can lead to financial success -- a mortgage to purchase real estate, a credit line to start a business or a student loan to fund a college education -- but a high-interest credit card balance usually doesn't. Pay down credit cards with the steepest rates as quickly as possible. Putting $250 a month toward that same $7,050 debt will retire it in three years and save you about $9,000 in interest versus making minimum payments. See Escape the Debt Trap for more strategies to chip away at what you owe.

Late fees, banking fees, credit-card fees -- the amounts might seem insignificant when taken individually. After all, an overdue library book or Redbox DVD might only run you a dollar. But if you're regularly paying penalties and fees, these charges can quickly eat a hole in your budget. Consider this: The average bank overdraft fee is $32.20, according to Bankrate.com, and the average charge for going outside your ATM network is $4.13. Late-payment penalties for credit cards can climb as high as $35.

So how do you avoid pesky fees? Read the fine print so you understand fee rules, and stay organized so you avoid breaching those rules. Here are 33 common fees you can avoid -- or at least reduce -- with just a bit of effort. With the extra cash, you can pay down debt or boost your savings.

Would you ignore a hundred-dollar bill on the sidewalk? Of course not. You'd bend over and pick it up. So why are you passing up other opportunities to get free money? If your employer matches employee contributions to a 401(k) but you're not participating in the retirement plan, then you're passing up free money. If you let rewards points from loyalty programs or credit cards expire, then you're passing up free money. If you claim the standard deduction on your tax return when you qualify for itemized deductions that could lower your tax bill even more, then you're passing up free money.

Believe it or not, there might even be free money out there that you forgot about -- or never knew of in the first place. There are more than $41 billion worth of unclaimed assets ranging from old tax refunds and paychecks to forgotten stocks and certificates of deposit being held by state agencies, according to the National Association of Unclaimed Property Administrators. Do a search on MissingMoney.com to find out if there are unclaimed assets that belong to you.

It's easy to focus on the present -- the bills you have to pay, the things you want to buy -- and assume you'll have time in the future to start saving for retirement. But the longer you wait, the tougher it will be to amass a sufficiently large nest egg. For example, if you wait until you are 35 to start saving for retirement, you'll have to set aside $671 a month to reach $1 million by age 65 (assuming an 8 percent annual return). But if you start at age 25, you'll need to save just $286 a month to hit $1 million by the time you're 65.

Even if you're creeping closer to retirement, it's not too late to start putting away money. In fact, Uncle Sam makes it easier for procrastinators to catch up on retirement savings. If you're 50 or over, you can contribute up to $23,000 annually to a 401(k) (versus $17,500 for those younger than 50). The contribution limit for older savers to traditional and Roth IRAs is $6,500 a year (versus $5,500 for everyone else). Use our Retirement Savings Calculator to figure out how much you need to save.

Does this sound like your investing strategy? You hear about a stock that is soaring, and you want to get in on the action, so you impulsively buy. But soon after, the stock starts tanking. You can't bear the pain of watching your shares decline further in value, so you immediately sell at a loss. As a result, you're wasting money rather than building wealth.

Unfortunately, many investors buy high and sell low because they follow the herd blindly into the latest hot stock. You can resist the urge to go with the crowd if you adhere to smart investing techniques. One such technique is dollar-cost averaging, a simple system of investing at regular intervals no matter what the market is doing. While it doesn't guarantee success, it does eliminate the likelihood that you're always buying at the top -- plus, it takes the guesswork and emotion out of investing. See the 7 Deadly Sins of Investing to learn how to overcome common missteps.

New stuff is nice, but it's often not the best investment. Take cars. Estimates vary, but some experts say a new vehicle loses 30 percent of its value within the first two years -- including an immediate drop as soon as you drive off the dealer's lot. According to Kelley Blue Book, the average vehicle is worth 44 percent less after five years.

If you're not comfortable buying something that someone else has owned, get over your hang-up because you're missing a big money-saving opportunity. Many pre-owned items can cost up to 50 percent to 75 percent less than the price you'd pay if you purchased them new. From designer jeans to college textbooks, here are 11 things that you should consider buying used because you often can find them in good or almost-new condition at a fraction of the price.

An early retirement is a dream for many, but calling it quits if you're too young has several potential drawbacks. For starters, you could incur a 10 percent early-withdrawal penalty if you tap certain retirement accounts, including 401(k)s and IRAs, before age 59½. (There are exceptions.) You can claim Social Security as early as age 62, but your benefit will be reduced by as much as 30 percent from what it would be if you wait until your full retirement age, which falls between 66 and 67 depending on your year of birth.

Health care is another big issue. You must be 65 to qualify for Medicare. In the meantime, without access to an employer-sponsored plan, you might have to pay a lot more out of pocket for individual coverage until you're eligible for Medicare.

And speaking of health, the longer you live in retirement, the more likely you are to outlive your nest egg. Let's say you make it to the age of 90. A $1 million portfolio evenly split between stocks, bonds and cash has a 92 percent likelihood of lasting until you turn 90 if you retire at 65, according to Vanguard. But retire at age 55 and the likelihood drops to 66 percent. Use our Retirement Savings Calculator to determine when you can really afford to retire.

This might be the single biggest obstacle on your path to riches. If you're not investing in continuing education, training and personal development, you're limiting your ability to make more money in the future. "Your own earning power -- rooted in your education and job skills -- is the most valuable asset you'll ever own, and it can't be wiped out in a market crash," writes Kiplinger's Personal Finance Editor in Chief Knight Kiplinger in 8 Keys to Financial Security.

Consider taking nondegree courses online to boost your knowledge of your field or enrolling in a graduate program (see 5 Advanced Degrees Still Worth the Debt). If you don't have a college degree, see our picks for best college values or check out these four alternatives to a four-year college degree. Just keep in mind that some college majors (think finance, computer science or nursing) lead to more lucrative careers than others (sorry, arts and humanities lovers).

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